Having a paid off home offers a lot of things. For one thing, from a simple cash flow management perspective it helps to keep your fixed costs down. From an emotional perspective, it’s nice to know that you fully own the home and no one can take it from you unless they are carrying a government badge. From an investment perspective it offers a guaranteed rate of return. But there are other things to consider about life after a paid off home.
The definition of having a paid off home
The definition of having a paid off home is that you no longer have a mortgage. If you no longer have a mortgage, you no longer pay interest on the loan, interest that could be deductible on your taxes. Let’s consider 2 different couples to illustrate this looking at their cash flows.
Couple A: Owns a $400,000 home and has a mortgage for $200,000. That mortgage requires that they pay $1,500 per month - $500 that is going toward interest and $1,000 that is going toward principal. At the end of the year, they qualify to deduct $6,000 on their taxes because of that $500 per month interest payment. That $6,000 deduction gives them $2,500 back in a check from the IRS due to their tax rate.
Couple B: Owns a $400,000 home and has no mortgage. Each month they have $1,292 more cash flow then Couple A next door (by adding up all the mortgage payments of Couple A, subtracting the cash back, and then dividing by 12).
So in the above example, having a paid off home has changed the lives of Couple B by adding $1,300 more into their monthly budget.
Where things can get more complicated is if we take an investment perspective and layer it on top of these couples’ situations. Assuming that they both make the same amount of money and both save the same amount of money:
Couple A: Has $200,000 in an investment account.
Couple B: Has no investment account but wants to catch up by investing their old mortgage payment.
Here’s where the numbers get very interesting:
1) If Couple A invests no more but Couple B adds their net savings of $15,600 to an investment account every year and they both get a modest return on their investment of 6%, it will take Couple B 24 years to have the same net worth as Couple A.
2) If Couple A invests no more but Couple B adds their net savings of $15,600 to an investment account every year and they both get a respectable return on their investment of 8%, it will take Couple B 40 years to have the same net worth as Couple A.
3) If Couple A invests no more but Couple B adds their net savings of $15,600 to an investment account every year and they both get a higher return on their investment of 10%, Couple B would never catch up with Couple A.
Depending on how you view the situation, having a paid off home can change your life. It can be a great thing if you are heading into retirement to not have that fixed expense weighing you down. It can also be a financial detriment if you paid it off prematurely without tending to your other investments at the same time.
The bottom line is that everything should be done with moderation and for what’s best in your individual situation. Have someone that is in your corner and can advise you on the possible outcomes.
The information contained in this communication does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Andrew Cremé and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance does not guarantee future results.
This case study is for illustrative purposes only. Individual cases will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making any investment decision, you should consult with your financial advisor about your individual situation. Raymond James does not provide tax, legal, or mortgage services. Please discuss these matters with the appropriate professional.